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Joseph E. Stiglitz: An Economist in Freefall

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In this week’s Acton Commentary, I review a new book by economist Joseph E. Stiglitz, Freefall: America, Free Markets, and the Sinking of the World Economy. Text follows:

A rare growth industry following the 2008 financial crisis has been financial crisis commentaries. An apparently endless stream of books and articles from assorted pundits and scholars continues to explain what went wrong and how to fix our present problems.

In this context, it was almost inevitable that one Joseph E. Stiglitz would enter the fray of finger-pointing and policy-offerings. As a Nobel Prize economist, former World Bank chief economist, former Chairman of the President’s Council of Economic Advisors, and member of the Pontifical Academy of Social Sciences, it would be surprising if he had nothing to say.

Moreover Stiglitz has assumed the role of social-democrat-public-intellectual-in-chief since his door-slamming departure from the World Bank in 1999. From this standpoint, Stiglitz opines about, well, pretty much everything. He also increasingly labels anyone disagreeing with him as a “market fundamentalist” or “conservative journalist.”

Yet despite his iconoclastic reputation, Stiglitz reveals himself in his latest offering, Freefall: America, Free Markets, and the Sinking of the World Economy, as a rather conventional Keynesian-inclined economist who, like most Keynesian-inclined economists, thinks everything went wrong in the early 1980s.

But before detailing the problems with Stiglitz’s analysis, let’s note what Freefall gets right. Stiglitz correctly observes that the financial crisis reveals deep-seated problems in mainstream economics. These include overreliance on mathematical modeling and questionable assumptions about the character of rationality. His laments about the lack of accountability on Wall Street for excessive risk-taking, the conflicts-of-interest that impaired ratings-agencies’ objectivity, and the Fed’s mismanaged monetary policy are also on target.

Stiglitz’s argument, however, quickly begins fraying when he claims the origins of the current financial mess lie in the economic liberalization which began in the late 1970s. But if that’s true, then how do we explain the fact that Western Europe’s hyper-regulated economies are presently in even worse shape than America’s? Today Greece is a nation on financial life-support. Yet it has long been one of the most regulated and interventionist economies in the entire EU.

This, however, doesn’t stop Stiglitz from proposing a massive expansion of regulation. This, he says, should be shaped “by financial experts in unions, nongovernmental organizations\… and universities”: i.e., people like Joseph E. Stiglitz.

More generally, there’s nothing new about what Stiglitz calls “New Capitalism.” It’s a return to old-fashioned Keynesian demand-management and the pursuit of “full employment” – that old Keynesian mantra – through the government’s direction of any number of economic sectors.

You’d think the fiasco of Fannie Mae and Freddie Mac (government sponsored enterprises with a congressionally-approved social engineering mandate) would underscore the folly of such approaches. But here it’s worth noting that Stiglitz coauthored a paper in 2002 titled, Implications of the New Fannie Mae and Freddie Mac Risk-Based Capital Standard. This stated that “on the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero.”

That little detail isn’t mentioned in Freefall.

Then there’s Stiglitz’s proposal for a Global Reserve System to effectively undertake demand-management for the world economy. To be fair, this is not an instance of megalomania on Stiglitz’s part. Keynes argued for something similar almost 65 years ago.

But here Stiglitz wraps himself – again – in contradiction. Having stressed the Fed’s inability to manage America’s economy, why does Stiglitz imagine a global central bank could possibly manage monetary policy for the entire world economy? What precisely, we might ask, is the optimal interest rate for the global economy? Surely only God could know that.

It is, however, in his last chapter – “Toward a New Society” – that Stiglitz becomes truly unstuck. Having stated that economic life should be organized in ways that political and economic rights are taken seriously, Stiglitz claims: “What should be clear…is that these matters of rights are not God given. They are social constructs. We can think of them as part of the social contract that governs how we live together as a community”.

Are rights mere social constructs? Well, that might be the view of your average UN bureaucrat or Ivy League professor, but it wasn’t the opinion of the signatories of Magna Carta or the Declaration of Independence. In short, it’s not so obvious that rights are man-made. If rights are simply social constructs, they’re not really rights in the sense of inalienable duties owed to people which cannot be created or extinguished at will by governments. Instead, they become privileges conceded to us by the state. And what the state gives, the state can take away.

In the end, Freefall is a book in which an old-line modern liberal gives us an old-line modern liberal response worthy of FDR or LBJ to the worst economic downturn since the Great Depression. It’s sad to see someone who has made considerable contributions to economics be so unoriginal. But in this instance, it seems that Joseph E. Stiglitz, like the Bourbons, has learned nothing and forgotten nothing.

Samuel Gregg


  • Roger McKinney

    Thanks for the review. I have known for a long time that Stiglitz was just another old socialist, so I don’t bother reading to much of his stuff.

    However I would quibble over this: “His laments about the lack of accountability on Wall Street for excessive risk-taking…”

    I realize it’s popular to portray bankers as riverboat gamblers, but history tells a different story. For example, here is a quote from an article from the Cato Institute:

    “In 1988, financial regulators from the G-10 agreed on the Basel (I) Accords. Basel I was an attempt to standardize the world’s bank-capital regulations, and it succeeded, spreading far beyond the G-10 countries. It differentiated among the risks presented by different types of assets. For instance, a commercial bank did not have to devote any capital to its holdings of government bonds, cash, or gold — the safest assets, in the regulators’ judgment. But it had to allot 4 percent capital to each mortgage that it issued, and 8 percent to commercial loans and corporate bonds.
    Each country implemented Basel I on its own schedule and with its own quirks. The United States implemented it in 1991, with several different capital cushions; a 10 percent cushion was required for “well-capitalized” commercial banks, a designation that carries privileges that most banks want. Ten years later, however, came what proved in retrospect to be the pivotal event. The FDIC, the Fed, the Comptroller of the Currency, and the Office of Thrift Supervision issued an amendment to Basel I, the Recourse Rule, that extended the accord’s risk differentiations to asset-backed securities (ABS): bonds backed by credit card debt, or car loans — or mortgages — required a mere 2 percent capital cushion, as long as these bonds were rated AA or AAA or were issued by a government-sponsored enterprise (GSE), such as Fannie or Freddie.”

    If this history is correct, there is no way bankers took excessive risk. In fact, they were trying to reduce risk by following the Basel accords.

  • It may have escaped your attention but Greece – like all other eurozone countries – fully liberalised its capital account and its security markets etc since the mid-1990s.

    The recent troubles of Greece have more to do with the fallout from the global banking crisis, and the global recession. These were amplified by the erosion of its competitiveness and its lack of ‘fiscal discipline’, as defined by the Growth and Stability Pact. For more details see:

    I am afraid also that your argument also falls flat on the other European examples, unless of course you think that Britain was over-regulated too.

    Panicos Demetriades
    Professor of Financial Economics
    University of Leicester (not an Ivy league institution)

  • Roger McKinney

    Panicos, what do you mean by “fully liberalised?” I know that US markets are no where near “fully liberalized” in the traditional sense. Banking is one of the most heavily regulated sectors. And Europeans bragged that their more heavily regulated banking sector would not suffer from the crisis the way US banks did.

    Yes, Greece’s troubles are largely the result of the world-wide depression, but isn’t that the point? To be responsible, governments shouldn’t act like the boom will last forever.

  • I mean according to the IMF’s new database on Financial Reforms. This is the most comprehensive and authoritative database on such things.

    Financial liberalisation does not mean lack of regulation. Financial markets are subject to various markets failures due to lack of transparency and externalities. Regulation is intended to address them and, if effective, can provide the confidence that market participants need, which allows private finance to flourish. Weak or non-existent regulation allows unscrupulous behaviour to take place, which undermines confidence. In such circumstances people want to deal with government banks or not bank at all. Northern Rock – the only government bank in the UK at the time of the crisis – experienced a huge influx of funds when confidence in private sector banks collapsed. For a more rigorous analysis of these issues see my article on government owned banks in the Journal of Development Economics 2008 (with S. Andrianova and A. Shortland).

    I agree with you that the previous Greek government acted irresponsibly. But so did many others. In my view, part of the problem is that politicians’ horizons are too short. As long as the party doesn’t finish during their term of office, someone else picks up the bill.

  • Jerry Henderson

    Postings that make their case by labeling someone as “socialist,” “capitalist,” or any other term meant to be demeaning are easily seen as lacking in intellectual strength. Name calling isn’t useful for making a case for your beliefs.

    Jumping to the discussion of regulation vs no regulation, one need only look to Canada. As of March 2010, the unemployment rate is 8.2% and falling. Canada is enduring this recession much better than the United States? Why? Canada actually has regulators who do regulate.

    When this implosion was occurring we were on a tour of Monument Valley. The lady sitting next to me was a Canadian. I asked her how Canada was handling this meltdown. Her reply,”Oh, we’ll be okay. We haven’t allowed the kind of speculation and risk taking that you do in the U.S.”

    I had no idea, at the time, if she was right. Turns out she was.